Answer to Question #150527 in Macroeconomics for chirag

Question

There is a high cross elasticity of demand between new and old cars”. Discuss the
statement by explaining the features of cross elasticity of demand. Also compare and
contrast cross elasticity with other types of elasticities of demand

Answer 1

The cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demanded of one good when the price for other good changes. Also called cross-price elasticity of demand, this measurement is calculated by taking the percentage change in the quantity demanded of one good and dividing it by the percentage change in the price of the other good.

A change in the price of one good can shift the quantity demanded by another good. If the two goods are complements, like bread and butter, then a drop in the price of one good will lead to an increase in the quantity demanded of the other good. However, if the two goods are substitutes, like plane tea and coffee, then a drop in the price of one good will cause people to substitute toward that good, and to reduce consumption of the other good.

Demand for used cars is highly elastic. If a used car of the same make and model wasn’t cheaper than the new one, every consumer would choose the new car instead of an old one. The fact is that a new car would sell at a discount and its rate almost equal to the new one then the customer will definitely buy the new car and the price will be elastic. So demand for the old car decreases when price of the new car decreases.

A positive cross-price elasticity value indicates that the two goods are substitutes. For substitute goods, as the price of one good rises, the demand for the substitute good increases. For example, if the price of coffee increases, consumers may purchase less coffee and more tea.

Comparison of cross elasticity with other types of elasticities of demand:

Price Elasticity of Demand: The price elasticity of demand, commonly known as the elasticity of demand refers to the responsiveness and sensitiveness of demand for a product to the changes in its price. In other words, the price elasticity of demand is equal to proportionate change in quantity demanded divided by proportionate change in price.

Income Elasticity of Demand: The income is the other factor that influences the demand for a product. Hence, the degree of responsiveness of a change in demand for a product due to the change in the income is known as income elasticity of demand. The formula to compute the income elasticity of demand is percentage change in demand for a product divided by percentage change in income.

Cross Elasticity of Demand: The cross elasticity of demand refers to the change in quantity demanded by one commodity as a result of the change in the price of another commodity. This type of elasticity usually arises in the case of interrelated goods such as substitutes and complementary goods. The cross elasticity of demand for goods X and Y can be calculated as proportionate change in the purchase of commodity X divided by proportionate change in the price of commodity Y.

Advertising Elasticity of Demand: The responsiveness of the change in demand to the change in advertising or rather promotional expenses is known as advertising elasticity of demand. In other words, the change in the demand as a result of the change in advertisement and other promotional expenses is called as the advertising elasticity of demand. The formula to calculate is proportionate change in demand divided by proportionate change in advertising expenditure.